1.4 Flashcards
How does the government applying indirect taxes correct market failure?
Indirect taxes are taxes placed on goods and services, and they can correct a market failure.
The government can place indirect taxes on demerit goods like alcohol or cigarrettes. When this happens, this increases the cost of production for a firm, and therefore firms put the price of these goods higher. This reduces demand and reduces the overconsumption of these goods. It internalises the external costs (meaning the producer/consumer bears the full cost of their actions, not just the private cost)
What are some evaluation points for indirect taxes to correct market failure?
- The tax needs to be set at a level that represents the full social cost of the negative externality, however thsi is difficult to calculate.
- Elasticity. Alcohol and other demerit goods tend to have an inelastic demand, so an increase in price wont lead to a significant decrease in quantity demanded. This wouldnt correct overconsumption.
- Potential for tax evasion and black markets
- Regressive nature of indirect taxes
Indirect taxes tend to be regressive, meaning they take up a larger proportion of income from lower-income households than from higher-income households. This can increase income inequality and place an unfair burden on lower-income groups. As a result, the social benefits of correcting market failure may be offset by the inequality caused by the tax.
How does the gov intervene and use subsidies to correct a market failure?
Subsidies encourage the production of goods that have positive externalites.
For example the givernment could give subsidies to firm that produce merit goods, which reduces their cost of production and leads to lower prices, increasing demand for these merit goods, which corrects the underconsumption of these merit goods.Eval
Evaluation oints against subsidies
- High cost to the government
- Can create dependancy, which reduces innovation.
- Can increase barriers to entry for new firms
How do max prices solve market failure?
Max price is a limit set on how high the price for a good can go. It is set below the equilibrium price.
Max prices enable consumers on low incomes to afford goods, they prevent inflation, and can prevent the explotation of consumers by monopolies who have significant price setting power.
However, applying a maximum price causes a shortage, as there is excess demand, and therefore this shortage means there is a risk that consumers are unable to find supplies of the product. The max price means that firms are unable to increase prices and therefore they cant make more profits, and therefore they may decde to leave the market to use their resources somewhere else where it is more efficient, and this would lead to a missing market and market failure.
How do min prices solve market failure?
Min prices are a limit set on how low prices for a good/service can go.
Min prices are usually set above the equilibrium price, and they ensure that producers recieve a fair price for their goods/services.
How do tradable pollution permits solve maret failure?
Tradable pollution permits is when the government sets a cap on the total amount of pollution that can be emmitted by firms. When firms have ermits left over they can sell these to other firms and increase profits.
This incentivises firms to reduce the amount of pollution they release, and this solves a negative externality.
How does the state provision of public goods solve market failure?
Public goods are non excludable and therefore the private sector isnt incentivised to provide public good because they wouldn’t earn the right amout of profits as people would avoid paying and they would free ride.
The private sector would therefore underprovide public goods, and in some cases they woudnt provide them at all, and this leads to a missing market, which would cause complete market failure.
The government can therefore provide public goods, and they are funded through taxation. This solves the free rider problem, and solves underprovision or missing markets by the private sector.
How does the government solve assymetric information?
The government can provide information, and this would solve market failure due to assymetric information.
The government could do this by eg:
- food labelling , health and safety warnings
what is gov failure?
Government failure refers to a situation where government intervention in the economy leads to outcomes that are inefficient, unintended, or worse than the market outcome that existed before the intervention. In other words, despite the government’s good intentions to solve market failures, their policies can sometimes create problems or exacerbate the issues they were trying to fix.
How do governments ditort price signals and cause market failure?
- Min prices
E.g. Minimum wage can lead to firms investing heavy in technology to lay off workers and cut costs leading to unemployment. - Max price
E.g. The gov can set max price on rent, to mae housing more affordable, but this could lead to landlords leaving the maret, leading to a shortage of homes. - Subsidies
This could lead to overproduction, wastage and inefficiency.
